Weekly Insights: Don’t Hold Your Breath Too Long if (Trading) Underwater
Don’t Hold Your Breath Too Long if (Trading) Underwater
Our topic this week is of course not swimming, but trading in a losing position. To be clear most professional traders do not hold onto these positions for very long. Once a trading position goes “underwater” most traders will immediately begin looking for an exit strategy — if they do not already have one in place (and most do) via protective stops.
I had lunch with my trading mentor the other day and he shared an insightful story with me. It went something like this: There once was a trader whose trading decisions were based upon using a “plumb-bob.” (In construction or land surveying, a plumb-bob is a turnip-shaped weight that is attached to a string to help determine if a structure is straight.) When this trader dangled the plumb-bob and it swung back and forth from north to south, he would buy. If the trader dangled the plumb-bob and it swung back and forth from east to west, he would sell. The trader had success using this methodology — with one simple rule applied: At the end of the first day if his position was “underwater,” he exited his trade first thing the next trading day.
The moral of the story is: Traders can (and do) have all kinds of trading strategies, but prudent money management is paramount. In other words, cut losses short!
Over the years, I have received emails and telephone calls from traders who were way underwater and had not prudently liquidated their losing trading positions. These traders were hoping the markets would turn around and losses would be reversed. Any time a trader has losses that are so big that “hope” comes into play, it is usually a situation where prudent money management has not been employed.
It is also important to mention that traders who know they have waited way too long to exit a losing position should not think already big losses cannot get even bigger — much bigger. I have heard many traders say, “Well, I have lost so much already that now I might as well wait for the market to turn around because it cannot go much further against me.” That is a recipe for disaster and potential financial ruin. This is where the saying, “Never meet a margin call” comes into play. If a trader gets a margin call from his or her broker, it is best just to close out the losing position and look for trading opportunities in other markets.
I have often mentioned this old trading adage: “A market will do anything and everything possible to frustrate the largest number of traders.” Guess which traders get the most frustrated? The ones who are hanging on to losing trading positions, waiting, and hoping for the market to turn around so they can get their money back. “I just want to get back to even” is a desperate quote heard by traders who are underwater. That “hope” is usually never realized.
One of the most interesting aspects of trading futures is that there are a few basic and effective rules that have been used by successful traders for years, some of which we will cover in future articles. However, adhering to these rules on a continual basis can be most difficult for many traders — including experienced veterans. Why is this? It is because some of the most effective rules in futures trading go against the grain of human nature. Indeed, the “psychology of trading” plays a vital role in trading success.
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